One of the most overlooked items on the purchase contract is the earnest money or good faith deposit. Sellers and agents are so anxious to see what the offer price is, they miss a key component of the offer.
What is a earnest money deposit? There is a good definition & article on the same subject here by Elizabeth Weintraub. My definition would be anything of value, mainly money, put forward by the buyer to show good faith to the seller that they are genuinely interested in buying the property. The deposit, plus the remaining down payment and the loan (or all cash) generally add up to the total purchase price of the property.
As Elizabeth points out, the amount of the good faith deposit a buyer should put down depends on the local market conditions and customs along with each buyer’s particular circumstances. In my local real estate market of Big Bear, CA, I have seen good faith deposits all over the board, from as little as $500 to as much as $100,000 at the high end. The amount of the deposit depends a lot on the purchase price amount. A good rule of thumb is somewhere in the range of 1-3% of the purchase price. It can be more or less, depending on the negotiations between the parties and their agents.
In California, the C.A.R. contract has a liquidated damages clause that says the seller can only hold up to a total of 3% of the purchase price if there is a breach of contract. By breach of contract, I am referring to a buyer who backs out of the deal without cause, typically after the 17-day due diligence period and all contingencies (loan, appraisal, home inspection, etc.) have been removed. On most occasions, the time the liquidated damages clause is initialed by both parties so a good faith deposit of more than 3% is rarely seen. One important item to note is that if the liquidated damages clause is not signed and there is a breach of contract by the buyer, they could be open to more than 3% of the purchase price in damages if the seller can show proof of the damages.
I would argue that the stronger the good faith deposit, the stronger the escrow & deal are going to be. One of the first things that I review on an offer sheet is the deposit. If the deposit is strong, around 3%, then it is a good sign the buyer is qualified and serious. If the deposit is weak, around 1% and less, then it raises the red flag in my mind. I will always recommend that my client/seller counter on that point if it is on the weaker end. I do not have any statistics on these numbers but I have noticed a definite correlation between a strong deposit and a strong escrow/closing as compared to a weak deposit and a weak escrow/deal falling through. A buyer that is willing to step up and write a 3% deposit shows seriousness, commitment, that they have some money in the bank, & some experience in buying property. A buyer who is not willing or able to put a strong deposit down shows the opposite characteristics. It is my belief that if a buyer really wants the property, they will step up to the requested amount the seller is looking for.
There are certain cases where it may be a first time buyer and they do not have a large deposit. I can certainly understand this situation. It is important in these cases to make extra sure these buyers are approved through a reputable lender, make sure the escrow time frame is not too long (45 days or less), and contingencies are removed early on. If I cannot get these terms either, it becomes the choice of the seller and how bad they want to sell knowing there could be some risk without any sizable return should the deal not go forward due to breach of contract by the buyer.
My father, who has been in the business since 1976, told me a good story when I first got in the business about the importance of a good faith deposit. He had a client come in the office looking to buy some lakefront property in the Big Bear area. The client was talking a big game & driving a fancy sports car. At one point he also mentioned that his boots were authentic snake skin or alligator (not sure but supposedly expensive). After taking him out to see some of lakefront properties, the buyer decided on one to buy and they went back to the office to write the offer. My father asked him for a good faith deposit to which he got a lot of excuses but no deposit. To that my dad replied, “well, what about one of the boots?” Needless to say, the client never ended up buying anything in the area.